Oil markets will remain weak until 2017 but should rapidly tighten thereafter; that’s according to analysts at Morgan Stanley who believe that most oil market participants are spending too much time concentrating on the oil markets of the Middle East and the United States when putting forecasts together.

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While these oil markets are important, Morgan’s analysts highlight that only 45% of the world’s oil supply comes from these two regions with 55% coming from other countries. Thirteen countries account for more than 70% of this non-US/non-Middle Eastern output, and according to Morgan’s analysts, the future of the oil market will be decided in these countries.

The 13 countries that will influence the oil market 

The 13 countries that are currently preventing the US and the Middle East from controlling the global oil market are ten non-OPEC countries – Azerbaijan, Brazil, Canada, China, Colombia, Kazakhstan, Mexico, Norway, Russia and the United Kingdom and three OPEC countries – Angola, Nigeria, and Venezuela. Last year this group accounted for 38 million barrels per day of production or 40% of global oil supply for the year.

Most of these countries have high oil production costs relative to the US and the Middle East and producers based in these regions are curbing output at a rapid rate. Indeed, Morgan’s analysts believe that production from nine of the 13 key producers (Angola, Azerbaijan, China, Colombia, Mexico, Nigeria, Norway, the UK and Venezuela) could fall by as much as 3.1mb/d during 2015 to 2020.

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However, these declines will be offset by production increases from Brazil, Canada, Kazakhstan, and Russia where, despite various headwinds, these countries are said to add 1.8mb/d in production by 2020. Most of this increase in production is due to the start-up of projects commissioned several years ago when the price of oil was significantly higher than it is today.

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Nonetheless, Morgan’s analysis shows that production growth from the four countries above is mostly front end loaded while the decline in the declining countries is mostly back-end loaded. With this being the case the bank’s analysts are expecting a small increase in production for 2017. After this pivot-point year, production declines are projected to accelerate with annual losses of 160 kb/d to 320 kb/d each year between 2018 and 2020 leading to a rapid tightening of the oil market during that period.

Will take time to rebalance 

Project lead times in the oil industry are often long, and this means that when the oil market starts to rebalance, shorter-cycle projects will have to pick up the slack to start balancing the market during those early years. The International Energy Agency expects oil demand to grow by approximately 1.2 mb/d per year in line with historical averages going forward. When you combine this demand figure with the projected decline in supply covered above, it quickly becomes apparent that the oil market might be beset by supply of shortfalls during the last few years of this decade and supply struggles to meet demand, old-fashioned market economics should drag the oil price higher. As Morgan explains:

“Assuming demand growing approximately 1.2 mb/d per year, as per the IEA’s forecast and in line with historical trends, we arrive at the conclusion that US crude will need to start growing at around 0.8-1.1 mb/d per year again to balance the market, meeting ~65% of global demand growth. This by no means aggressive: the US has already accounted for 69% of the world’s crude oil supply growth during the 10 years from 2005-15.

Over the last year from April 2015 to April 2016, US production has declined 0.76 mb/d. The swing to 0.8-1.1 mb/d of growth requires a substantial further improvement in the economics of shale production. It is unlikely that this can be delivered by cost savings alone – ‘price’ will also have to play its role.

Hence, we see prices stuck in a $40-55/bbl range over the next 6-9 months, but $70+ from 1Q18 onwards”

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Morgan Stanley: Oil Is Heading To $70